Wall Street's wish: Year-end rally

Investors also worry about potential fizzle

November 20, 2005|By Tom Petruno, a columnist for the Los Angeles Times, a Tribune Co. newspaper

You can almost smell the mix of hope and desperation on Wall Street as December nears.

There is widespread belief that a year-end stock rally is inevitable--and that it will be enough of a rally to significantly improve on the low-single-digit gains that broad market indexes now are showing for 2005.

There also is widespread fear of the potential fallout if the market's recent gains fizzle.

For one thing, a lot of professional money managers may find themselves bonus-free early next year if their portfolio performance doesn't improve markedly in the next six weeks.

There also is a risk that lousy numbers on year-end brokerage and mutual fund statements could further sour investors on U.S. stocks, setting a bad tone for 2006.

The U.S. equity market has been relegated to second, third or worse fiddle this year in terms of where investors have wanted to stash their dollars.

Real estate, of course, has been No. 1 on many peoples' must-have list. Cash also has become more interesting as the Federal Reserve kept pushing up short-term interest rates.

And even when they've directed money toward stocks, far more investors this year have opted to buy foreign shares than U.S. shares, at least as measured by cash inflows to mutual funds.

That has been quite a good call: The average foreign stock fund is up 10.9 percent year to date, compared with a 5.4 percent gain for the average U.S. fund, according to Lipper Inc.

For the U.S. market overall, this year is looking like a downsized version of 2004: Once again, the Dow Jones industrial average is struggling to eke out a gain. The Dow was down 0.2 percent for the year as of Friday, not including dividends.

But as in 2004, profit opportunities in equities haven't been as elusive as the Dow's woes might suggest.

A Standard & Poor's index of 600 small-company stocks is up 6.8 percent for the year. An S&P index of 400 mid-sized stocks sported an even better gain, at 9.9 percent.

The Dow transportation-stock index was up 9 percent for the year, thanks to a run-up of more than 15 percent since mid-October, as falling oil prices have helped to stoke fresh interest in railroad, trucking and airline shares--or at least in airlines that aren't in bankruptcy.

The Dow utility-stock index is up more than 18 percent for the year, despite a pullback since early October.

Still, investors are more likely to own an S&P 500 index fund than a utility- or transportation-stock fund. And the S&P 500, like the Dow, doesn't have a lot to show for itself this year. It's up 3 percent, not including dividends.

To ask for the S&P 500 to stage a strong advance is to ask for a rising-tide-lifts-all-boats rally. Many market veterans don't think that's likely soon. And even if it does happen, they say, it isn't likely to be sustainable.

Venice, Fla.-based Ned Davis Research, a data firm well known on Wall Street, turned negative on the U.S. market early in October. The firm advised clients to cut their U.S. portfolio to 40 percent stocks, from 55 percent, and keep the rest in bonds and cash accounts.

Tim Hayes, chief investment strategist at Ned Davis, said the firm hasn't been this downbeat on U.S. shares since 2000, when the last bear market began.

With the Fed continuing to tighten credit and energy prices still elevated, although off their recent peaks, "We think the market risk is pretty high now," Hayes said.

On the other hand, the bullish case for U.S. stocks doesn't seem like such a big stretch. The economy still seems to be growing at a healthy pace; corporate profits rose at a double-digit rate in the third quarter, for the ninth straight quarter, according to data tracker Thomson Financial; oil prices are falling; and the Federal Reserve probably is closer to the end of its interest-rate-raising campaign than to the beginning.

But is any or all of that enough to get people wildly excited about stocks overall again, and soon?

Forget the rising-tide idea, many market pros say. That's usually a good bet early in a bull market, but not later in one.

Better to just make sure your portfolio has enough of what has been working well, and could continue to work well, even if the U.S. market as a whole remains uninspired.

Hayes, for example, said the Japanese market looks like it is in a long-term recovery after a 13-year bear phase that ended in 2003.

John Bollinger, head of Bollinger Capital Management in Manhattan Beach, Calif., says he isn't ready to predict the end of the road for small- and mid-size U.S. stocks, even though they have on average beaten blue chips every year since 2000.

"The economy has been doing much better than people expected," Bollinger said. In that environment, small- and mid-size companies offer the best opportunities for strong earnings growth, he said.

Of course, the danger in favoring what has been working best is that you could end up a slave to the momentum game--buying only what's hot, while ignoring the true bargains.